Email this article

The SEC recently issued a wakeup call to auditors: Report all abuses committed by clients or risk receiving a civil injunction.

This action arises from the case involving the SEC vs. Solucorp Industries Ltd. and its auditor, Glenn Ohlauser.

Here’s what happened: On December 13, 1999, the SEC filed a civil injunctive action claiming that senior officers and directors of Canadian company, Solucorp Industries Ltd., entered into a “deliberate and systematic scheme to defraud investors over a four-year period.”

Recommended Stories:

The company is incorporated in Canada’s Yukon Territory but headquartered in West Nyack, N.Y. It began trading on the NASD OTCBB, which is the Bulletin Board, in 1996 after voluntarily delisting itself from the Vancouver Stock Exchange after an eight-month trading suspension.

It registered its securities with the SEC under Section 12(g) of the Exchange Act in February of 1998. The SEC then suspended trading in Solucorp’s securities less than three months later.

On October 31, 2000, the SEC amended the complaint to include Glenn R. Ohlhauser, a Chartered Accountant with the Canadian Accounting firm, MacKay & Partners. This is the first time the SEC has ever brought a civil injunction against an auditor who has violated Section 10A of the Securities Exchange Act of 1934, which requires auditors to disclose any illegal acts they discover upon conducting an audit.

According to the SEC’s complaint, Ohlhauser evaluated the information gathered during MacKay’s review of Solucorp’s September 30, 1997 interim financials and his own audit of Solucorp’s December 31, 1997 financial statements. He then “reasonably concluded that Solucorp had backdated a licensing agreement between the company and Smart International Ltd. to September 15, 1997 for improper purposes relating to its accounting treatment of income from a license fee.”

Ohlhauser further concluded that Solucorp had improperly recognized $500,000 in revenues from this licensing agreement, which represented 40% of Solucorp’s total reported revenues for the quarter.

Throughout the audit, Ohlhauser informed Victor Herman, the former chief financial officer of Solucorp’s two principal operating subsidiaries and the preparer of Solucorp’s consolidated financial statements, of the misrepresentation, twice explaining that the September 30, 1997 financial statements were “materially misstated as a result.”

According to MacKay, Ohlhauser was informed by Solucorp’s officers that although the agreement was not finalized until December 31, it was, in fact, still in place. “When it came to the actual signing of the agreement,” says MacKay, “it was just a formality.”

MacKay says that while Ohlhauser openly acknowledged the backdating of the agreement, he believed Solucorp’s justification for the backdating, which eradicates any guilt on his part.

The SEC, however, claims that as of September 30, 1997, payment of the license fee was subject to material contingencies; Solucorp’s revenue recognition did not conform with GAAP, and its financial statements were significantly “misstated.”

If Ohlhauser had minded Section 10A of the Securities Exchange Act of 1934, he would have reported the incident straight to the SEC, after going up through the company’s chain of command.

Paul Berger, the SEC’s Associate Director of Enforcement tells CFO.com: “Ohlhauser had an obligation to fulfill, which he failed to achieve.” Berger adds: “In the course of his engagement, he violated section 10A. He identified a contract that was only contingent upon other events. He noted in a memo to the company that the contract was wrongfully backdated.”

In other words, Ohlhauser should not have been so quick to accept Solucorp’s reasoning.

As a trained and experienced professional, Ohlhauser should have been more persistent in his attempt to rectify Solucorp’s statements, exposing Solucorp’s actions immediately to the SEC, considering Solucorp was so uncooperative, according to the complaint. Because he didn’t, Ohlhauser joins the accused officers of Solucorp, thus representing the first auditor who will ever be tried for such a crime.

The SEC is seeking a “Final Judgement of Permanent Injunction, permanently restraining and enjoining Ohlhauser from violating Section 10A of the Exchange Act.”

“It is extremely important for us to address cases like this where facts indicate inappropriate conduct, especially by a relatively new statute,” says Berger.

The SEC also filed lesser charges against two New York CPAs who supposedly failed to reveal possible accounting violations at Detour Magazine.

In a third case, the SEC is charging Edward Horton, a managing partner at Horton & Co., for independence violations, as well as material misstatements related to valuing options.

As for Ohlhauser? He left MacKay & Partners on May 31 to take another job with a dot-com company, says MacKay. “It had nothing to do with the Solucorp issue,” he adds.

And what about MacKay & Partners? “We have resigned as auditors from Solucorp,” notes MacKay. “With Glenn absent, we did not feel that we had sufficient expertise to carry on.”

Aside from its approximate 25 public company clients, the firm also decided that it will “no longer do audits for SEC registrants.”